Continued focus on SPA warranty and indemnity claims and insurance

Decision Holdings and Bidco – continued focus on SPA warranty and indemnity claims

Summary

Warranties and indemnities (W&I) in SPAs are provided by sellers of a target company to the buyers as comfort that they have properly represented the state of the target prior to its sale. Recent decisions have brought to the fore some of the issues in construing both SPA provisions, and the W&I insurance designed to cover breaches.

Court decisions on warranties and indemnities

The starting point for both claims under SPAs and W&I insurance claims is to identify a representation or warranty in the SPA that has been breached. Absent breach, there is neither an SPA loss nor a W&I claim. It follows that cases concerning alleged SPA breaches are of interest to both insurers and insureds and their brokers.

In interpreting all contractual terms, the English courts will seek to ascertain the objective meaning of the language which the parties have chosen to express their agreement, starting with the objective meaning of the words (the textual interpretation) but as necessary considering the factual background and the rest of the contract (the contextual approach). This applies to both SPAs and W&I Policies. Recent cases have demonstrated that courts will still adopt a forensic approach to analysing the words in the relevant contracts themselves. Despite decisions in other areas, that remains the key starting point. The court will avoid re-writing contractual terms simply because it considers one or other party has entered into a bad bargain.

Examples of SPA disputes in 2023 which demonstrate the Court’s approach to construing SPAs include the following.

1. Next Generation Holdings Ltd v Finch. In this case, the court found that false income accruals in the target’s accounts had overstated its income, concealing a very significant deficit in the client money account at the time of the share sale. The Court concluded that these were not honest overestimates, did not give a true and fair view of the financial position and had amounted to fraudulent breaches of the accounts warranties in the SPA.

2. Millbrook Healthcare Bidco Ltd (formerly Cairngorm Acquisitions 9 Bidco Ltd) v Croll concerned an agreement to vary one contract with the effect of limiting sales, and waiver of a right to recover accrued debt under a specific invoice issued under another, was not consistent with the financial information provided and meant that there were breaches of the accounting warranties that the accounts gave a true and fair view of the assets and liabilities and that the management accounts were not materially mis-stated.

3. More recently, the Court of Appeal handed down Decision Inc Holdings Proprietary Ltd & Anor v Garbett & Anor, which is instructive in a number of respects as we explore further below.

Decision Holdings was an appeal against a decision that there had been a breach of warranties in an SPA by the seller of shares in a software development company; at first instance they had been found liable to the tune of £1.3m. The nature of the business meant that income came in project-based “lumps” rather than as a steady flow. Prior to the share sale, documents setting out “pipeline” opportunities and potential future projects had been prepared. Many of these opportunities did not in the event bear fruit, so that the business’s post-sale results were poor relative to the pre-sale projections.

At first instance, it was held that there had been a breach of warranty by the sellers as regards the “prospects” of the company. The Court of Appeal disagreed; the judge had incorrectly approached the claim on the basis that the prospects warranty required an assessment of the expected or forecasted level of the sales/profit with the “actual position at the date of the contract”. This approach gave rise to various problems, at the heart of which lay the fact that this was not what the relevant warranty in the SPA actually said. The Seller had warranted that “Since the Accounts Date… there has been no material adverse change in the turnover, financial position or prospects of the Company…”. Therefore, for there to have been a breach of warranty, there must have been a deterioration in the target’s prospects since the Accounts Date. The warranty did not permit the buyer to compare the actual prospects as at conclusion of the SPA with those a hypothetical reasonable buyer would have had based on the warranty at the same date. That approach did not recognise both the significance of what was being compared, nor the dates to be used for that comparison. Furthermore, the Judge had been wrong to equate “prospects” with EBITDA and wrong to assess the warranty by reference to historical EBIDTA rather than how the target might perform in future.

The Court also held that the contractual notice given in respect of the alleged breaches was defective, so that no breach of warranty claim could succeed. Clause 11.4 of the SPA provided that the defendants should not be liable for a “Claim” unless given notice in writing “summarising the nature of the Claim (in so far as it is known to the Buyer) and, as far as is reasonably practicable, the amount claimed”. The Court of Appeal construed this to mean that this means a notice should be given which stipulates the amount claimed in respect of each particular breach of warranty rather than by reference to an “omnibus figure”.

W&I insurance - Finsbury Foods v Axis and Angel Bidco

The SPA decisions also show the issues that an insured can be faced with when trying to establish cover under its W&I insurance. Absent a breach of the representations or warranties in an SPA, there can be no claim under either a seller side or buyer-side W&I policy. This point has been reinforced in a couple of recent W&I coverage decisions.

In particular, this was crucial to the decision that insurers could decline cover in Finsbury Foods Group Plc v Axis Corporate Capital UK Ltd . In that case, there was no breach of any insured warranty or indemnity. As a result, there was no cover under a W&I policy. In Finsbury Foods, the court took the view that recipe changes and price reductions by a bakery business post-SPA were not breaches of warranty. Absent breach, there was no covered event under the insurance policy (the claim also failed based on the prior knowledge exclusion).

Our article here provides more detailed analysis.

The insured’s claim in Project Angel Bidco Limited (in administration) v Axis Managing Agency Limited & Ors was declined for a different reason. Following the acquisition of shares in a construction company, conduct which is now subject to a police investigation emerged at the target company. The local council which had been the company’s main client withdrew most or all of its business. The warranties and indemnities in the relevant SPA included (in summary) warranties that there were no pending or threatened legal proceedings, no investigations or enquiries underway (or circumstances which may give rise to investigation or enquiry), and no offences has been committed under the Bribery Act 2010 involving the company’s directors, officers or employees (“ABC Liability” warranties).

The W&I Policy contained an exclusion in the main body of the policy that excluded any Loss to the extent that it arose from “any ABC Liability". ABC Liability was defined as being “any liability for actual or alleged non-compliance by any member of the Target Group or any agent, affiliate or other third party in respect of Anti-Bribery and Anti-Corruption Laws.” The Policy contained a Schedule which identified which warranties in the SPA were insured. This specifically included as covered the ABC Liability warranties in the SPA. However, this coverage summary was prefaced with a clause that stated “Notwithstanding that a particular Insured Obligation is marked as “Covered” or “Partially Covered”, certain Loss arising from a Breach of such Insured Obligation may be excluded from cover pursuant to Clause 5 of the Policy”.

The court held that the meaning of the various policy terms was entirely “unequivocal and coherent”. It found that the loss was excluded by virtue of the ABC Liability exclusion, despite the fact that the ABC Liability warranties were marked as covered in the coverage summary schedule. The court’s view was that an ordinary insured would have no difficulty understanding that, in order for an exclusion to apply, obligations must first be “covered”. In addition, the coverage summary was clearly made subject to the exclusion clause (clause 5) in the main body of the Policy. The Insured also argued that the ABC Liability definition contained a typo, and should have read that liability was excluded for “any liability for actual or alleged non-compliance by any member of the Target Group or any agent, affiliate or other third party in respect of Anti-Bribery and Anti-Corruption Laws…” rather than “any liability or actual or alleged non-compliance…”. This was dismissed by the Court on the basis that the clause was clear: it excluded the liability or the fact of actual or alleged non-compliance with anti-bribery or corruption laws.

Commentary

These decisions serve as a useful reminder of a number of key points relating to SPA warranties and indemnities, and W&I insurance:

• The first is that the warranties and indemnities in an SPA, and W&I insurance too, cannot be a complete substitute for the need for proper due diligence by the buyer, nor will they respond simply because the buyer subsequently decides it is unhappy with the bargain it has struck.
• Secondly, the contractual terms should be carefully drafted and closely analysed to determine whether there has been a warranty breach, or an indemnity has been triggered. The same applies to the W&I Policy terms too. The basic starting point for seller or buyer side W&I Policies is that there must have been a representation or warranty breach to trigger cover. No breach, no cover, unless there is an element of synthetic cover written into the W&I Policy. But even a warranty breach may be excluded under the terms of the W&I Policy. Or, there may be separate underwriting requirements and potentially additional premium payable to extend cover (we see that with cyber related representations and warranties, for example).
• It is always important to ensure that contractual claim requirements are followed, particularly in the claim notification made from buyer to seller under an SPA. A legitimate claim that a buyer has against a seller for a substantial amount could, in some cases, be rejected because of a failure to the follow those requirements at notification stage.

More generally, it is reassuring to see the Courts remain focussed on the forensic analysis of the terms of contracts such as insurance policies, rather than attempting to re-write contracts to create a different deal that is perceived after the event (and often when circumstances have changed) to be “fairer” to both parties. The facts and circumstances known or assumed by the parties at the time the document was executed remain relevant. In the W&I insurance cases noted above, this included a clear articulation of the purpose of the W&I insurance. In the context of SPAs, this includes an implicit acknowledgment that there are good reasons why parties focus on and draft particular representations and warranties by reference to particular points in time. It is not for the Court to insert what it considers to be “better” representations or warranties in their place.